RBI tightens restructuring norms,
Bad debts expected to double in
2 years
In a bid to clean up the banking
system RBI came up with the proposal
for higher provisioning for the restructured loans. Rating agency ICRA expects
the gross NPA percentages of the banking system to shoot up because of the
move. The NPA in Indian Banking System is expected to rise 6.5-6.75% by
June 2015. The strict provisioning is
expected to bring down the restructuring advances by 15-30%. The banks likely
to be hit hardest by these norms are
PNB, Indian Bank and OBC with over
10% of their advances in restructured
category.

The RBI cut the Repo rate,
the rate at which RBI lends to the
banks, and Current Reserve ratio
(CRR), percentage of reserves to be
maintained by RBI, by 25 basis points in
the Q3 review of monetary policy.
While Repo rate will bring
down the borrowing cost for the banks
and thus would enable it to lens to
individuals and corporate at lower rates
the reduction in CRR would increase
the availability of funds in the market.
The Repo rate currently stands at
7.75% and CRR at 4%. This move is
considered to have infused Rs.18000
crores into the system.

of fiscal deficit and the current account
deficit. The market is not expecting any
further reduction in the CRR for at
least next 6 months.

Despite these measures RBI
has expressed concerns about the state

Government yet to receive investment proposal from Foreign Retailers

Government and LIC working together to contain the fiscal deficit
within 5.3% of GDP:

Itâ&#x20AC;&#x2122;s been over 4 months that government
almost put its survival on risk and fought
the intense opposition to allow foreign
supermarkets to enter Indian market but
it is yet to receive its first investment
proposal. Most of the global retailers are
on wait-and-watch mode and are asking
for more clarifications before starting
here. The 30% mandated local sourcing
requirement is considered to be the
basic hindering force which is preventing
the entry of these industries.

The state run insurer has started selling
shares of private sector companies like
Larsen &Toubro and Mahindra & Mahindra
to create a corpus for bidding for the OIL
India. Both LIC and Government have been
working really hard to make their divestment scheme a success in a bid to contain
fiscal deficit within the budgeted target.
This time Government is pushing LIC to be
an early bidder which is likely to help in
drawing investors.

US economy shrinks in Q4

The US economy Shrank in Q4
performing worse than any economic forecasts. Gross Domestic Product dropped at
0.1% annual rate. This is the first time in
last 3 years that US economy has shrunk.
Last time it happened in second quarter of
2009 when the world economy was still in
recession. One of the biggest plunge in the
defence spending and dwindling inventory
growth are the primary restraining forces
believed have to cause this.

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Did You Know?

4 Feb 2013

1. Did you know that money has a short life span? On average a $1 bill lasts only 18 months, a $5 bill
will last two years and a $10 bill will last three years. This is why the U.S. Bureau of Engraving &
Printing has to reprint $541 million worth of currency each year.
2. The original name of Bank of America was Bank of Italy. After the Great depression, in 1928, its
name was changed to Bank of America.
3. A piece of currency can be folded forward and back 4,000 times before it will tear.
4. If you had 10 billion $1 notes and spent one every second of every day, it would require 317 years
for you to go broke.
5. The highest-price stock currently sold on the NYSE is Warren Buffett's Berkshire Hathaway, Class A
(NYSE: BRK-A), which sells for around $126,500. That means you can buy about
190shares of Apple (Nasdaq: AAPL) ($666 per share) for the cost of one share of Berkshire Hathaway.
6. The first stock exchange can be traced back to Antwerp, Belgium in 1460. Rather than buying and
selling shares of companies (which did not yet exist), brokers and lenders congregated there to deal
in business, government and even individual debt issues.
7. 100 of the Fortune 500 companies have R&D facilities in India.

Gold (10gm â&#x20AC;&#x201C; 22carat): Rs.27808.09 as on Feb 1, Mumbai
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Exchange Rate: Rs. 53.16 /USD as on Feb 2

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4 Feb 2013

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After fiscal cliff its the debt ceiling

The Fiscal Cliff crisis which would have resulted in a sharp decline in the Budget deficit was resolved by the
passing of the American Taxpayer Relief Act of 2012. Now that the Fiscal cliff has been resolved, another
crisis is looming over the country. The Debt ceiling crisis in the US has become a much debated issue
nowadays. The ceiling is a limit set by the Congress upon the amount of money that can be borrowed by the
Government for public spending. This limit of $16.4 trillion was reached on December 2012 and then
extraordinary measures were taken by the Treasury Department to allow spending temporarily in January
2013. These Extraordinary measures can work only on a short term basis and so a
better solution of suspending the debt limit was sought. On the 1st of February
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2013, the Senate agreed to suspend the debt limit in the interim period till May
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19. So, the debt ceiling issue has been put to rest for the time being.
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Financial engineering is a field of study involving financial theory, tools of mathematics and practices of
programming.
Financial engineering involves the use of tools from the fields of applied mathematics, statistics, economics
and computer science to address current financial issues. Although in the modern day much of financial
engineering involves devising new and innovative financial products.
Financial engineering has led to the explosion of derivative trading that we see today. In 1973 Fischer Black
and Myron Scholes, two renowned economists developed what is called the Black-Scholes model for a
financial market containing derivative instruments. They derived a partial differential equation, called the
Black–Scholes equation, which governs the price of the option over time. A number of investment bankers
then started to use the formula to fix the prices of options. Needless to say, this led to a boom in options
trading.
How does it apply in practice?
It is one of the most effective models to determine fair prices of options.
The model has the following advantages:
Ease of applicability and calculation.
 Reversibility – Just as how price is determined, other variables can be calculated by giving the price
as an input.
 It helps in more accurately determining the movement of prices


Black-Scholes model comes with its own caveat. That is, the proper implementation of the formula would
require a thorough understanding of the assumptions made. It only takes into account certain domains of
risk.
For example, it does not assume tail risk (probability of rare dangerous events).
It also does not take into account liquidity risk. It assumes that the trading would be instant (immediate
availability of money upon trading).
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Above all, given that the formula was formulated as recently as 1973, it would not
be able to encompass the behavioural elements such as herd mentality, greed etc.
It would take some time and study to ascertain how those elements could be
incorporated at least to a certain extent.
This leads us to the question of how such engineered financial models impact
modern day markets.
An Engineered Crisis?
In 2008, the world economy was in a tail spin, caused primarily by various
financial institutions losing enormous sums of money. The US government had to

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4 Feb 2013

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Financial Engineering – A product of our age ?

inject more than one trillion dollars into its economy, and offer various bailout packages to various banks and
financial institutions. The accumulated losses of the financial institutions during that time are more than the
profits recorded in all of history. It is therefore important to understand the role (if any) of financial engineering models in such crises.
Financial engineering makes heavy use of the models. It is possible that several practitioners of financial
engineering were blindly applying various formulas, without understanding what assumptions led to these
formulas. Efforts to incorporate behavioural factors such as the herd mentality, greed etc in the pricing of
options are still in infancy.
Are statisticians to be blamed then?
It is a natural tendency for people to know who the real villains were. In fact they would even want villains
even if there were not any. So the question is “Were the statisticians the real villains?”
Probably not.
The problem was more due to an environment which encouraged risk taking. Financial managers modelling
exotic products by blindly applying formulas and banks generally involving in off-the-balance sheet activities
are proof.
The reward system for financial managers and traders encouraged them to come up with innovative financial
products giving them neither the time nor the responsibility to properly understand the models’ assumptions
and limitations.
The laws governing the industry blurred the line dividing ‘investment’ banks which speculated with money
and ‘traditional’ banks which did less of speculation and more of safe-keeping. In the 1990’s, laws governing
traditional banks allowed them the opportunity to speculate more with the money given to them for
safekeeping. They had the freedom to create various ‘special purpose vehicles,’ resulting in ‘off-balance
sheet transactions.’ These off-balance sheet transactions effectively meant that the balance sheets of banks
did not reflect their true financial health. This gradually led to unsustainable levels of speculation and that
was where it all started.

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